Is Free Market Capitalism Bad Economics?

Tuesday, November 21, 2017

The “fatal flaw” of neoliberalism, which “denotes a preference for markets over government, economic incentives over cultural norms, and private entrepreneurship over collective action,” is that it simply is “bad economics,” according to a new Guardian article penned by Harvard economist Dani Rodrik.

The one size fits all formula can be overly simplistic but that could be said for any economic philosophy.

“Neoliberalism” Criticisms

Most of Rodrik’s article is thoughtful and nuanced. His primary criticism of “neoliberalism,” is that, “its customary remedies – always more markets, always less government – are in fact a perversion of mainstream economics. Good economists know that the correct answer to any question in economics is: it depends.”

He’s correct. The one size fits all “more markets, less government,” formula for economic policy can in many cases be overly simplistic and will not produce the best outcomes in every socioeconomic context, but that could be said for nearly any economic philosophy and really isn’t incredibly innovative as an argument.

It is, however, worth noting that one of the reasons why many “neoliberals” advocate for less government intervention in the economy is precisely because they don’t trust a centralized state authority to have the proper knowledge to know when it is appropriate to intervene, and to what degree, in the interactions between millions or even billions of consumers and producers.

Much of the rest of the article gives the reader the impression that Rodrik is not being entirely fair to “neoliberalism,” as an economic philosophy. For one, in spite of his rebuking neoliberals for making sweeping economic statements, he himself claims that neoliberalism, “does not even get the economics right… it is bad economics.”

There are a great number of empirical studies that examine how neoliberal reforms affect economic development.

Rodrik also seems to downplay the importance of neoliberal reforms in the role of the success of countries like China whilst laying the blame for crisis or stagnation in Chile and Mexico entirely at neoliberalism’s feet. As observed by Noah Smith in Bloomberg, “Rodrik cherry-picks quite a bit.”

What Does the Research Show?

Importantly, there are a great number of empiricalstudies that have examined how neoliberal (i.e free market) reforms affect economic development that go unmentioned in Rodrik’s article.

For example, Wacziarg and Welch (2008), using quantitative analysis and a thorough review of country-specific case studies of economic liberalizations, find that liberalizing countries “experienced average annual growth rates that were about 1.5 percentage points higher than before liberalization.”

Estevadeordal and Taylor (2008) find that, on average, countries that engage in free trade reforms see considerable accelerations in economic development relative to the control group, such that the income per capita of the liberalizers is 25% higher after a quarter-century.

Lastly, Billmeier and Nannicini (2013) compare the post-liberalization economic development trajectory of treated countries with the trajectory of a combination of similar but untreated countries and conclude that, economic liberalization has “by and large, a positive – or at least non-negative – impact on the trajectory of real income per capita.”

The wage and price effects of Mexico’s trade liberalization, “lifted 3 million individuals out of poverty.” Notwithstanding Rodrik’s reference to Mexico as “a particularly sad example,” Billmeier and Nannicini’s estimates show that in 2000, Mexican income per capita was 21 percent higher than it otherwise would have been had it not liberalized. A World Bank research paper on the topic even concluded that the wage and price effects of Mexico’s trade liberalization, “lifted 3 million individuals out of poverty.”

And while Chile’s free-market reforms imposed under the violent rule of Augusto Pinochet in the 1970’s initially produced disaster, the liberalization process did, in fact, continue, resulting in Chile becoming not only the freest economy in Latin America but one of the wealthiest as well.

So Is Free Market Capitalism Bad Economics?

Perhaps neoliberals do need to engage in a little introspection and be more open to the idea that free markets aren’t perfect and can even lead to calamity, but any honest examination of the evidence strongly suggests that, in general, the movement towards free markets has produced meaningful and beneficial results across the world. It isn’t a coincidence that the global shift towards the embrace of ‘neoliberalism’ has been accompanied by unparalleled reductions in global poverty, particularly in China and India.